Opinion: The Fed should let the economy run some more

MichaelMadowitz

We’re down to two jobs reports and two Federal Reserve meetings left this year, and the economic climate is beginning to feel a lot like the end of last year — with a renewed push for higher rates from some members of the Federal Open Market Committee, even as the data continue to show a strengthening labor market with no signs of inflation.

So, what’s going on? We’re in the middle of a pretty fundamental debate about what monetary policy is supposed to do.

The September employment report came in as good news for workers and for monetary doves — the unemployment rate was essentially unchanged at 5% as the labor force grew by 444,000 people and we added 156,000 jobs. Over the last year, average hourly earnings grew 2.6%, outpacing inflation, and in September, we got Census data showing that after nearly a lost decade of growth, real median household incomes were up by 5.2% in 2015 from the year before.

In many ways, the macro environment is in Goldilocks territory, and that presents a challenge for Fed officials who argue for higher rates.

Ultimately, it’s pretty hard to interpret the Fed’s dual mandate into a case for higher interest rates right now. We’re not yet at maximum employment, and if prices are not stable, it’s deflation that’s the worry.

But that’s much easier for those of us who aren’t voting on policy to say. We don’t have a lot of experience with a labor market like this, and we’re already well beyond the point where monetary policy makers are used to raising rates, so there’s a natural inclination to want to move in that direction — even if the data don’t say so.

Similar to the end of last year, 2016 is winding down, and FOMC members who won’t vote next year are thinking about how voting for another year of low rates in an improving economy reflects on them. I think it reflects well, but concerns are understandable.

Even if monetary policy is appropriate for the labor market, there’s still a lot to worry about.

Some members have pointed to the possibility of bubbles as a reason to raise rates. Others are worried about what the labor market looks like beyond the data we can see right now. Things are going well, but only because we’re adding jobs at a healthy clip and inducing more workers to join the labor market.

The bubbles question is an important one — we’re quite familiar with how the end of the housing bubble went, and nobody seems keen to repeat it. But the real question for the Fed, and government more generally, is not whether financial stability is a good thing — it is! — it’s whether broad monetary policy is a reasonable tool for achieving stability.

If Fed officials are worried about financial stability, they need to decide between focusing their efforts on reigning in risks in the financial system, or on using interest rates that affect a much broader swath of the economy. This is a pretty fundamental monetary-policy debate, and one that we’re probably going to be talking about for years to come, especially if the long-term trend of falling interest rates continues.

The labor-supply question is interesting, and getting a lot of attention, but the rumors of labor-force participation’s death have been greatly exaggerated. In part, this is because wage growth has been softer than in previous recoveries, until the last few years.

There’s nothing unprecedented about people working even though they would rather be doing other things. Workers in pain or workers pained to give up their video games fit pretty nicely into economic models — people work until the downside of working is exactly equal to the wages they earn.

A decade of slow wage growth means that there’s considerable scope for wages to keep rising without inflation, in part because these rising wages can make working even more appealing than video games. This isn’t rocket science — it’s basic economics — and this is one case where the dismal science gives reason for hope.

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